Some investment professionals work hard to make their work confusing. They believe they have a vested interest in creating investor confusion. They use jargon that can intimidate and make it difficult to understand relatively simple concepts.
But investing is not that complicated. It can be broken down into two major beliefs.
• You believe in the ability to make superior share selections, or you don’t
• You believe in the ability to time the Markets, or you don’t
Let’s have a look at which investors have which belief systems and where you should be with your own beliefs.
If we break investment decision matrix down into four quadrants, then quadrant one is the Noise Quadrant. It characterised by investors who believe it is both possible to time the markets and pick better stocks.
They think that they or their favourite financial guru can consistently uncover mis-priced investments that will deliver Market-beating returns. In addition, they believe it’s possible to guess whether entire Market segments or geographical areas will go up or down.
The media need you to return to them time and time again and encourage this thinking to try and sell newspapers, magazines and TV shows.
Conventional wisdom is quadrant two and includes most of the financial services industry. Most professionals (including financial planners and stockbrokers) won’t bet the farm on predicting markets swings with any degree of accuracy and know that making incorrect predictions on stock selections can mean losing clients.
However, they do believe that there are fund managers and high tech information systems out there that will find undervalued securities for their clients and add value.
Most economists believe fundamentally that capital markets work and so in an efficient Market this methodology adds no value on average.
Quadrant three, Tactical asset allocation quadrant, is populated by investors that think the markets are efficient and stocks are priced accordingly, and they (and only they!) can see mis-pricing in entire Market sectors.
They believe the way to add value is by buying a Market they think is undervalued and wait until other investors realise their mistake and then selling when the market is considered to be fairly valued again.
If you believe that stock prices are priced fairly, we think it is inconsistent to accept that market prices would be incorrectly priced as, after all, this is an aggregate of the fairly priced individual securities!
No prudent investors are found in this quadrant.
Finally, and most crucially, is the Information Quadrant.
Most of the academic community and institutional investors reside here. They believe that dispassionate research into what works, and then following a rational course of action based on empirical evidence is the way to go.
As far as results from the first three quadrants are concerned, research indicates that on average, they return no better than the Market after fees, transaction costs and taxes.
Passive investments, those in quadrant four, because of their lower costs have higher returns on average than the other types of investment over time.
Clearly there are instances of Market timing and stock selection providing better returns than the passive approach but we believe these are not consistent enough to warrant the typically higher costs.
Investors need to make smart decisions about their money and we believe that they should move from the Noise Quadrant to the Information Quadrant as this is where you should be to maximise the probability of achieving all your financial goals.
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